mca port overview final

7/31/2019 MCA Port Overview Final

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Overview of the framework

Need for a framework

Economic growth and trade expansion in recent years have

enhanced the relevance of port sector as a critical element in

globalisation of the Indian economy. In particular, this sector

has been witnessing significant interest from both domestic

as well as foreign investors following the policy initiatives

taken by the Government of India to promote Public Private

Partnerships (PPP) on Build, Operate and Transfer (BOT)

basis. However, the actual inflow of investment has been less

than expected, and future prospects will depend on adoption ofa comprehensive policy and regulatory framework necessary

for addressing the complexities of PPP, and particularly for

balancing the interests of users and investors. Moreover,

transformation of rules will have to be accompanied by a

change in the institutional mindset.

This volume responds to the need for evolving a model

document that reflects best practices, particularly from the

perspective of public policy on the one hand and bankability

of projects on the other hand. Besides all the advantages

associated with such a document, this would also enhance the

possibilities of securing upto 20% of the capital costs by way of

viability gap grants from the Central Government coupled with

long-term debt from the India Infrastructure Finance Company

(IIFC) for funding upto 20% of the project costs.

For building and operating port terminals on BOT basis,

a precise policy and regulatory framework is being spelt out

in a Model Concession Agreement (MCA). This framework

addresses the issues which are typically important for limited

recourse financing of infrastructure projects, such as mitigation

and unbundling of risks; allocation of risks and rewards;

symmetry of obligations between the principal parties;

precision and predictability of costs and obligations; reduction

of transaction costs; force majeure; and termination. It also

A comprehensive

framework

is a pre-requisite

for PPP


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deals with other important concerns such as user protection;

transparent and fair procedures; and financial support from

the Government.

The MCA also elaborates on the basis for commercialising

ports in a planned and phased manner through optimal

utilisation of resources on the one hand and adoption of

international best practices on the other. The objective is to

secure value for public money and provide efficient and cost-

effective services to the users.

Elements of financial viability

The four critical elements that determine the financial

viability of a port terminal are traffic volumes, port tariffs,concession period and capital costs. The concession period

typically granted by the Port Trusts is 30 years. This timeframe

should normally enable a robust project structure and any further

extension would improve financial viability only marginally as

the present value of projected revenues after 30 years would be

comparatively low from the Concessionaires perspective.

The capacity constraints currently faced by major ports

mean that there is effectively no competition in the port sector.As a result, cargo movement at each port is virtually captive

and volumes are not normally volatile. Over time, efficiencies

at the port level would contribute to traffic diversion across

competing ports, but that would pre-suppose creation of

sufficient capacity at the respective ports.

In view of the limited competition between ports today,

the Government would continue to determine the tariff but it

should be capped in line with the tariffs prevailing in the region.

A pre-determined tariff structure would also lead to greater

predictability of the revenue streams of Concessionaires,

besides incentivising efficiency and cost reduction. In the

medium term, tariffs should find their own levels through

competition, but that can happen only after adequate capacity

has been created.

PUBLIC PRIVATE PARTNERSHIP IN PORTS


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As three of the four above-stated parameters would thus be

virtually pre-determined, capital cost is the variable that will

determine the financial viability of a port BOT project. Bidders

may, therefore, seek an appropriate capital grant/subsidy from the

Government/or the respective Port Trust (the Trust) in order toreduce their capital investment for arriving at an acceptable rate

of return. Though PPPs undertaken so far in the sector have been

financially viable and self-sustaining, the Governments initiative

to build large capacities (with redundancy of upto 30%) could

give rise to the need for Government support in some cases.

Technical parameters

Unlike the normal practice of focussing on construction

specifications, the technical parameters proposed in the MCA

are based mainly on output specifications, as these have

a direct bearing on the level of service for users. Only the

core requirements of design, construction, operation and

maintenance of the port terminal are to be specified, and

enough room would be left for the Concessionaire to innovate

and add value.

In sum, the framework focuses on the what rather

than the how in relation to the delivery of services by theConcessionaire. This would provide the requisite flexibility

to the Concessionaire in evolving and adopting cost-effective

designs without compromising on the quality of service for

users. Cost efficiencies would occur because the shift to

output-based specifications would provide the private sector

with a greater opportunity to innovate and optimise designs

in a way normally denied to it under conventional input-based

procurement specifications.

Performance standards

At the port terminal, the Concessionaire would not only

procure the civil works and equipment, it would also provide

services in the form of cargo handling. The efficiency of its

Technical parameters

will focus on the level

of service for the users

OVERVIEW OF THE FR AMEWORK


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services would normally reflect in the dwell time of cargo at

the port terminal. The framework identifies benchmarks for key

performance indicators such as dwell time, berth productivity,

vehicle service time and ship handling productivity, and

specifies penalties for continued failure in achieving therequisite levels of performance.

Concession period

The guiding principle for determining project-specific

concession period should normally be the capacity of the

respective port terminal to handle the expected cargo at the

end of the proposed concession period. However, in the

case of port terminals, capacity constraints would normally

be addressed by construction of additional terminals at the

same or adjacent ports. As such, it would be advantageous to

allow a longer concession period both from the perspective

of the concessionaire as well as the Government. The Major

Port Trust Act, 1963 stipulates a maximum period of 30 years

and unless there are reasons for making an exception, the

concession period should normally be fixed at 30 years.

The time required for construction of a port terminal (about

two years) has been included in the concession period so asto incentivise early completion, leading to maximisation of

revenues.

Selection of Concessionaire

Selection of the Concessionaire will be based on open

competitive bidding. All project parameters such as the

concession period, tariff, price indexation and technical

parameters are to be clearly stated upfront, and short-listedbidders will be required to specify the proportion of revenues

from user charges that they are willing to share with the Port

Trust. The bidder who offers the highest revenue share should

win the contract. In exceptional cases where instead of offering

a revenue share, the bidders seek a capital grant/ subsidy

from the Government/ Trust, the bidder who seeks the lowest

Competitive bidding

on single parameter

will be the norm

Concession period

to be normally

thirty years


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grant would win the contract, subject to a maximum subsidy

of 20% of project cost and an additional 20% for O&M after

commissioning the port terminal.

Concession fee

Concession fee will be a fixed sum of Re. 1 per annum for

the concession period. Where bidders do not seek any grant

and are willing to make a financial offer to the Government/

Trust, they will be invited to quote a higher concession fee

in the form of a share in revenues from tariffs. The revenue

share quoted for the initial year could be increased for each

subsequent year by an additional 1%.

The rationale for the above fee structure is that in theinitial years, debt service obligations would entail substantial

outflows. Over the years, however, the Concessionaire will

have an increasing surplus in its hands owing to the declining

debt service and rising revenues. Recognising this cash flow

pattern, the concession fee to be offered by the Concessionaire

will be based on an ascending revenue-share structure.

Risk allocation

As an underlying principle, risks have been allocated to the

parties that are best able to manage them. Project risks have,

therefore, been assigned to the private sector to the extent it

is capable of managing them. The transfer of such risks and

responsibilities to the private sector would increase the scope

of innovation leading to efficiencies in costs and services.

The commercial and technical risks relating to

construction, operation and maintenance are being allocated

to the Concessionaire, as it is best able to manage them. Other

commercial risks, such as the rate of growth of cargo traffic,

are also being allocated to the Concessionaire. The traffic risk,

however, is significantly mitigated as the port is virtually a

monopoly where existing traffic volumes can be measured with

reasonable accuracy. On the other hand, all direct and indirect

Risk alleviation and

mitigation is critical

to private investment

Concession fee shouldbe levied when revenue

streams can sustain it



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political risks are being assigned to the Government/ Trust.

It is generally recognised that economic growth and port

connectivity will have a direct influence on the growth of

traffic and that the Concessionaire cannot in any manner

manage or control these elements. By way of risk mitigation,

the MCA provides for extension of the concession period in the

event of a lower than expected growth in traffic. Conversely,

the concession period is proposed to be reduced if the traffic

growth exceeds the expected level.

The MCA provides for a target traffic growth and stipulates

an increase of upto 7 years in the concession period if the

growth rate is lower than projected. For example, a shortfall of

10% in the target traffic after 20 years will lead to extensionof the concession period by 5 years. On the other hand, a

reduction of up to 3 years is stipulated in the event of a higher

than expected growth. For example, an increase of 6% in the

target traffic will reduce the concession period by 18 months.

Financial close

Unlike other agreements for private infrastructure projects

which neither define a time-frame for achieving financialclose, nor specify the penal consequences for failure to do

so, the MCA stipulates a time limit of 180 days for achieving

financial close (extendable for another 120 days on payment

of a penalty), failing which the bid security shall be forfeited.

By prevalent standards, this is a tight schedule, which is

achievable only if all the parameters are well defined and the

requisite preparatory work has been undertaken.

The MCA represents the comprehensive framework

necessary for enabling financial close within the stipulated

period. Adherence to such time schedules will usher in a

significant reduction in costs besides ensuring timely provision

of needed infrastructure. This approach would also address

the present problem of infrastructure projects not achieving

financial close for long periods.

Project implementation

must commence as per

agreed timeframe


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Port tariffs

A balanced and precise mechanism for determination of tariffs

has been specified for the entire concession period since this

would be of fundamental importance in estimating the revenue

streams of the project and, therefore, its viability. The tariffs shall

be based on the rates to be notified by the Government.

The MCA provides for indexation of the tariffs to the

extent of 40 per cent thereof linked to WPI. Since repayment

of debt would be substantially neutral to inflation, the said

indexation of 40 per cent is considered adequate. A higher

level of indexation is not favoured, as that would require the

users to pay more when they should be receiving the benefit

of a depreciated asset. A higher indexation would also add touncertainties in the financial projections of the project.

Construction

Handing over possession of the required land and obtaining

of environmental clearances are being proposed as conditions

precedent to be satisfied by the Government/ Trust before

financial close.

The MCA defines the scope of the project with precision

in order to enable the Concessionaire to determine his costs

and obligations. Additional works may be undertaken within

a specified limit, only if the entire cost thereof is borne by the

Government/ Trust.

Before commencing the collection of tariffs, the

Concessionaire will be required to subject the Port Terminal to

specified tests for ensuring compliance with the specifications

relating to safety and quality of service for the users.

Operation and maintenance

Operation and maintenance of the Port Terminal is proposed

to be governed by strict standards with a view to ensuring a

high level of service for the users, and any violations thereof

Tariffs should be

determined with great

care and precision

Service quality

and safety must

be ensured


Maintenance

standards will be

enforced strictly


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Pre-determined

termination payments

should provide

predictability

would attract stiff penalties. In sum, operational performance

would be the most important test of service delivery.

The MCA provides for an elaborate and dynamic mechanism

to evaluate and upgrade safety requirements on a continuing

basis. The MCA also provides for traffic regulation, security

and rescue operations.

Right of substitution

In the port sector, the project assets do not constitute

adequate security for lenders. It is the project revenue streams

that constitute the mainstay of their security. Lenders would,

therefore, require assignment and substitution rights so that the

concession can be transferred to another company in the event offailure of the Concessionaire to operate the project successfully.

The MCA accordingly provides for such substitution rights.

Force majeure

The MCA contains the requisite provisions for dealing

with force majeure events. In particular, it affords protection

to the Concessionaire against political actions that may have a

material adverse effect on the project.

Termination

In the event of termination, the MCA provides for a

compulsory buy-out by the Government/ Trust, as neither the

Concessionaire nor the lenders can use the port terminals in

any other manner for recovering their investments.

Termination payments have been quantified precisely as

compared to the complex formulations in most agreementsrelating to private infrastructure projects. Political force majeure

and defaults by the Government/ Trust are proposed to qualify

for adequate compensatory payments to the Concessionaire

and will thus guard against any discriminatory or arbitrary

action by the Government/ Trust. Further, the project debt

would be fully protected by the Government/ Trust in the event

Lenders will have the

right of substitution

Concessionaire will

be protected against

political actions


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of termination, except for two situations, namely, (a) when

termination occurs as a result of default by the Concessionaire,

only 90 per cent of the debt will be protected, and (b) in

the event of non-political force majeure such as Act of God

(normally covered by insurance), only 90 per cent of the debtbeyond the insurance cover will be protected.

Monitoring and supervision

Day-to-day interaction between the Government/ Trust

and the Concessionaire has been kept to the bare minimum

following a hands-off approach, and the Government/ Trust

shall be entitled to intervene only in the event of default. Checks

and balances have, however, been provided for ensuring full

accountability of the Concessionaire.

Monitoring and supervision of construction, operation

and maintenance is proposed to be undertaken through an

Independent Engineer (a qualified firm) that will be selected

by the Government/ Trust through a transparent process. Its

independence would provide added comfort to all stakeholders,

besides improving the efficiency of project operations. If

required, a public sector consulting firm may discharge the

functions of the Independent Engineer.

The MCA provides for a transparent procedure to ensure

selection of well-reputed statutory auditors, as they would play

a critical role in ensuring financial discipline. As a safeguard,

the MCA also provides for appointment of additional or

concurrent auditors.

To provide enhanced security to the lenders and greater

stability to the project operations, all financial inflows and

outflows of the project are proposed to be routed through an

escrow account.

Support and guarantees by the Government

By way of comfort to the lenders, loan assistance from the

Government/ Trust has been stipulated for supporting debt

A credible and fair

arrangement for

supervision is essential



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service obligations in the event of a revenue shortfall resulting

from political force majeure or default by the Government/

Trust. Guarantees and/ or compensation have also been

provided to protect the Concessionaire, though for a limited

period, from construction of competing port terminals whichcan upset the revenue streams of the project.

Miscellaneous

A regular traffic census and annual survey has been

stipulated for keeping track of traffic growth. Sample checks

by the Government/ Trust have also been provided for.

As a safeguard against siphoning of revenue share by the

Concessionaire, a floor level in present and projected traffic

has also been stipulated.

The MCA also addresses issues relating to dispute

resolution, suspension of rights, change in law, insurance,

defects liability, indemnity, redressal of public grievances and

disclosure of project documents.

Framework for new ports

The framework contained in the MCA is applicable toPPPs in building new port terminals at existing ports. With

some modifications, it can be applied to transfer of existing

port terminals from the Government/ Trust to private entities.

Similarly, with some modifications, it can also be applied to

PPPs for building new ports on BOT basis.

Conclusion

Together with the Schedules, the proposed framework

addresses the issues that are likely to arise in financing of port

projects on BOT basis. The proposed regulatory and policy

framework contained in the MCA is critical for attracting

private investment with the concomitant efficiencies and lower

costs, necessary for accelerating growth.

Support and

guarantees by

the Government

are essential

An effective dispute

resolution mechanism

is critical

Private participation

should improveefficiencies and reduce

costs

mca port overview final

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